Ponzi economies

I’ve been reading news reports a lot recently about Chinese banks lending money to companies in various sectors, just so they can stay alive long enough to pay back their previous loans.

I’ve had various reactions to that. Throwing good money after bad; the cover-up’s worse than the crime; can we really trust Chinese capitalization data knowing that some of that money is being wasted; and how does anyone think that’s a good idea, given that the reasons these companies are going bankrupt because of powerful long-term trends (like severe oversupply), not some short term blip?

The response that Western readers will identify with the most, I expect, is this one: it’s a Ponzi scheme. There are many variants (for convenience, I’m lumping in pyramid schemes as well) but the basic essence of a Ponzi scheme is to take capital as income. These bankrupt companies are consuming bank capital to pay their basic expenses, not to make forward-looking investments. For some reason, the banks are willingly entering into this arrangement.

This mixing of accounts is something I’ve encountered a lot, in various forms. I a friend working in a tech startup, who told me, “people in my company don’t work too hard. It’s not like a tech startup in Silicon Valley. We just got a capital infusion, and we don’t really have to worry about anything until about two years from now.” Even in a company that should be innovative sales-driven, it is the boss who is feared, not the customers.

This mixing of accounts can even be seen in legal terms. I have been learning more about company setup in China, and one of the (many) strange facts I’ve discovered is that wholly foreign-owned enterprises (WFOEs) sometimes pay tax on capital infusions as if they were income.

These are unrelated examples – and I hardly know as much as I really should to be to write this post – but I feel sort of confident in saying that Chinese accounting doesn’t employ the firewall between the current and capital account (in national accounting terms; or expenses and capitalization) as in the US and Europe. This firewall is the most important reason that accounting exists in the first place. Ironically, this situation is the opposite when we’re talking about national accounting. China keeps very close track of current and capital accounts, and some old regulations even required companies to use separate bank accounts for these two accounts. So, I guess the conclusion to draw here is that Chinese collectivism doesn’t just mean looking out for those less fortunate, but is rather a very literal accounting principle. Its lack of use for individual company accounting may help explain, if not excuse, its behavior towards various accountants recently.

Now, having gotten this far, I may as well talk about China’s partner in crime, the US. Richard Perry, in his failed presidential bid, controversially called Social Security a “Ponzi scheme.” It is true, but not in the way he meant it: it is true because Social Security savings, represented by government debt, are simply being “spent,” rather than “invested” in infrastructure and other long-term projects. China also invests in those same government bonds, because it assumes that any country would balance their economy from a top-down perspective. The US, meanwhile, buys Chinese products under the assumption that their suppliers are geared towards making a profit. And we end up with a very big culture clash.